# Target Net Income

Target net income is the target profit that top management or shareholders set for the company to achieve in an accounting period. It is the goal for company to achieve in a year. At the beginning of the year, each company prepares the annual budget, which is the target for company to achieve during the year. We can not just set the target net income alone as it has a close relationship with sales, variable cost, and fixed cost.

In order to complete the target, the company needs to understand the relationship between variable cost, fixed cost, and selling price. It is usually called the cost-profit analysis. Before achieving target net income, we need to hit the sale target, budgeted variable cost, and fixed cost.

Account Name Amount
Sale 000
Variable Cost (000)
Contribution Margin 000
Fixed Cost (000)
Operating Income 000
Tax on Profit (000)
Net Income 000

The top managements may have no interest in all the figures here, they just want the company to reach a certain of net income during the year. But as the management account, we have separated all the figures in order to bring a clear message to all departments. Sale departments must know about their target, production department needs to ensure that the variable cost must be within the control and the so on.

We need to calculate:

• Target Operating Income
• Target Contribution Margin
• Target Sale quantity

## Target Net Income Formula

$Target\ Operating\ Income = {Target\ Net\ Income \over 1 – Tax\ Rate}$

Then, Target Contribution Margin = Target Operating Income + Fixed Cost

$Target\ Sale\ quantity = {Target\ Contribution\ Margin \over Contribution\ Margin\ per\ Unit}$

## Example

Company ABC is preparing a budget for each department after the board of directors had set the target net income for next year. The target net income is $200,000, and the variable and fixed costs are:  Description Amount Selling Price$ 100 Variable Cost $40 Fixed Cost$ 300,000 Tax rate 30%

## Solution

#### First, we need to calculate the Net operating income.

Target Operating Income = Net Income/(1 – Tax rate)

Net Operating Income = Net Income / (1 – 30%)

#### Finally, calculate the target sale quantity

Sale quantity = Total Contribution / Contribution per unit

Sale Quantity = $585,714 /($100-$40) = 9,761 units It means that Company ABC needs to sell 9,761 units to achieve a contribution margin of$ 585,714. So the company will be able to get a net operating income of $285, 714, and net income of$ 200,000.

## Conclusion

Target net income is the best method which we use to make the connection between shareholder/top management and the other departments. Sale department will be notified about their target sale to support target profit. They can challenge back if it is too high and suggest any marketing strategy.

Production department must keep the cost within the standard cost otherwise it will reduce the profit. They have to control the material wastage, worker idle time and product quality. These are the factors that will impact to cost of goods sold.

It also happens to the expense such as rental, utilities, payroll, and other fixed costs, the management needs to ensure that they are not significantly increased during the year. Usually, they overestimate them around 5%-10% base on the nature of business.